Is the downgrade of Malta’s long-term credit rating to BBB+ from A- by Standard & Poor’s important? Not many people have realised that the downgrade places us just three levels above a junk rating. Neither have there been any comments on the fact that the short-term credit rating was kept at A-2. Both are significant and have significant implications.
My first comment relates to the juxtaposition of the downgrade in the long-term rating and the retention of the short-term rating. This sends a strong message to investors that few have understood.
I do not count among the latter, the Prime Minister and the Minister of Finance, who know very well the import of S&P’s ratings decision but obviously are desperately trying to minimise it.
Once one reads the motivations for S&P’s decision, it is clear why the long-term sovereign rating was downgraded.
The main reasons are: the “recurrent budgetary risks” incurred by loss-making state-owned enterprises, mainly Enemalta; the high debt burden of 91 per cent, which “could continue to increase on the back of weaker-than-projected growth or stock-flow adjustments”; and doubts about the “quite optimistic” real GDP per capita growth projections. A fourth one, though not as crucial, is a low female labour participation rate.
These are four factors that are most unlikely to respond to measures in the short-term, which is what the Budget is about.
The losses of state-owned enterprises can only be reduced in the medium to long-term after substantial internal restructuring of the enterprises and their financing.
The debt burden cannot decrease before the Government starts registering a surplus in the public finances and the Prime Minister himself said the other day that, under his government, that will not happen before 2015 at least, and subject to favourable international economic circumstances.
Most analysts considered the Budget’s economic projections on the high side, given that the eurozone has slipped into recession again and growth cannot be stimulated overnight.
There is no reason why the female labour participation rate should not continue to rise with the right incentives but, again, this is only achievable in the medium to long-term because it also involves cultural and social changes that are not amenable to short-term budgetary measures.
Therefore, how the Prime Minister could declare that he is “certain” that the downgrade will be reversed once the Budget is approved stretches the imagination. There is absolutely nothing in the Budget that will impact the above four factors in such a material way that it will induce S&P’s to revise its long-term rating. Even if we were to achieve the economic growth target, the other three factors will play out over a three to five-year period.
The Prime Minister and the Finance Minister have blamed the downgrade on the botching of the Budget. This was not the driving factor, though it is mentioned by S&P’s.
However, as I have explained, it certainly was a secondary factor, though a minor one at that. In fact, S&P’s maintained its short-term credit rating. Why?
Because though the Budget debacle does not help, S&P’s expects it to be approved immediately after the election, either by a Nationalist or a Labour government.
Does the downgrade matter? Credit agency ratings affect international borrowing or foreign holdings of Maltese bonds. Both are limited.
Our international borrowing is not extensive, being limited to amounts that are not sizeable within the national context, though they feature prominently in Enemalta’s finances, for example. Foreign holdings of Maltese bonds are also quite restricted.
The direct impact of the downgrade, therefore, is circumscribed.
It will, however, impinge significantly on any further borrowing by Enemalta or other enterprises as it will raise their cost of financing, if not make it more difficult.
The indirect impact, however, can be significant. Credit ratings send a strong signal to investors. Countries ignore them at their peril.
Downgrades have the effect of raising doubts about a country’s creditworthiness or may make investors perceive it as being more risky to do business in that country.
Can anybody quantify this? Certainly not but the effects are there nonetheless. The downgrade does not help and may actually inflict some damage.
The S&P’s downgrade has delivered a blow to the Nationalist Government at a very delicate time in the election campaign. No amount of wriggling will change that, let alone silly remarks about the Opposition being responsible for the downgrade.
It certainly dents the Government’s economic credentials. But it also sends a strong signal to Maltese policymakers. It is inviting them to think deeply about the policies they intend to follow and their impact on the economy and the public purse.
It is normal that, in the battle to win votes, all sorts of promises are made by the political parties. Only idiots will believe that all the promises can be honoured.
As for myself, I prefer to be guided by who could, on the balance, deliver on the key policies. I also comfort myself by the thought that, once a political party is in government, it will take note of the realities and act accordingly.